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2} (40 points) Fiscal Policy/Loanable Funds Question Consider the following change in fiscal policy for an economy that was initially operating at its potential level

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2} (40 points) Fiscal Policy/Loanable Funds Question Consider the following change in fiscal policy for an economy that was initially operating at its potential level of output. Suppose that the U.S. federal government notably cut personal and business taxes and did not change spending, which together greatly increased its current decit- to-GDP ratio from 0 to 4 percent. Despite a very modest, direct positive effect on business investment, the actions notably increased the budget decit relative to GDP while having virtually no effect on private saving. Assume for the sake of this question that these policies are implemented and are sustained for many years in a closed-economy environment. a. (30 points] How would this affect the market for Ioanable funds in the United States? Your answer should cover i. ...the supply curve for Ioanable funds, ii. ...the demand curve for those funds, and iii. ...the equilibrium real interest rate. I am interested only in direction of movement, so calculations are not required. For each of these variables, your choices include ...no change [applicable in principle to any of the three}, ...a shift right or left (applicable in principle to demand and supply curves), ...movement up or down an unchanged supply or demand curve, ...an increase or decrease [applicable in principle to the real interest rate), or ...not enough information to tell (applicable in principle to any of the three]. Briefly explain your reasoning for each, including what information is missing if you choose the last option. (10 points apiece for a correct answer for each of the three items requested, including 7 points for the correct direction plus a correct chart and 3 points for the reasoning). Is this b. [2 points) Does this policy crowd out or crowd in private investment? c. [8 points] Instead, now use the Solow Growth Model. What would the fiscal policy action in 2a likely do {on net) to steady state U.S. output in the long-run and why: i. ...no change (applicable in principle to any of the three), ii. ...induce an increase iii. ...induce a decrease. Briefly explain your reasoning for the answer. (4 points for the correct direction and 4 points for the reasoning}

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